Wednesday, February 02, 2005

The Principled Case Against Social Security Privatization: An Outline

by Tom Bozzo

While I was feeling a little warm and fuzzy about the possibility of engaging the right blogosphere last night, I happened upon this passage at Professor Bainbridge (which goes on to recount, via Bob Kerrey, a Daniel Patrick Moynihan witticism):
Why are the Democrats so vehement in their opposition? Perhaps it's on the merits; there are legitimate policy reasons to worry about private accounts, although on balance I think the arguments in favor of them are stronger.

Yes, there are policy arguments to be made on both sides. The seed of debate is sown! (OK, there's been the 'Thrilla in Hyattsvilla' [hilarious if you're a U. Md.-College Park alum] and ongoing discussions between various liberal economists and econobloggers and Andrew Samwick.)

Now, you can't say that Paul Krugman and the left blogosphere have been asleep on the Social Security reform topic. However, I don't know that I've seen a comprehensive case presented in a while. So at the risk of eliding important details, I thought I'd assemble a sketch. Who better than me, with my 30-odd daily visitors, to take this up? Suggestions from the interested are welcome as always.

For the most part, I won't address any of the arguments Prof. Bainbridge might deploy on the pro side, including counterarguments to items listed below, though I'll also largely omit the other side's unsavory marketing tactics, about which plenty has been said elsewhere. Nor will I address the political side of things, where again I think the Democrats are right to take a hard line.

I'll add annotations and links as I find them and as time permits. So here goes.

1. Social Security is effective at reducing poverty among seniors and other beneficiary groups and provides a useful income supplement to most beneficiaries who wouldn't live in poverty without it.

2. Whatever plan is proposed, it will be untested, and the track record for state pension privatization in other countries is poor.

3. Social Security's funding problems are realtively minor and, other things equal, transition costs for private accounts make any Social Security funding problem worse.
In short, a basic conservative virtue: if it ain't broke, don't fix it.

4. The transfer of risk from the government to private individuals is unwarranted.

5. The sustained high expected real returns assumed by privatization proponents would not be available under the economic assumptions used to score Social Security's program health (see Dean Baker, via MaxSpeak).

6. If high real expected returns are available, they can be captured at lower transaction cost compared to private accounts by allowing the Social Security Trust Fund to invest in private assets.

7. Regardless of the level of expected returns, actual private returns are not risk-free.
Items 4-7 are interrelated. Risk-averse individuals will rationally accept lower expected income for greater income certainty. A more risk-neutral intermediary (the Trust Fund) can improve welfare by capturing the higher returns while smoothing out market-driven fluctuations in returns for individual beneficiaries. Meanwhile, transition costs and management costs for a large number of small private accounts will take a significant bite out of expected returns, the latter unless private investment choices are carefully circumscribed to a limited set of very low-cost options.

Granted, turning the Social Security Trust Fund into something resembling other large pension funds would not be a minor reform.

8. Privatization would unjustifiably increase income and wealth inequality.
Market inequality already implies a social welfare function with bizarre marginal social utilities of wealth. For a moral perspective, Catholics might note the social justice articles of the Catechism.
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